Q
– I like the idea of managing my own investments. I enjoy online trading.
But sometimes I feel like the red tape involved gets to be too much. There
seems to be a never-ending pile of statements, notices, advisories, and tax
forms. Those worry me the most, because I’m not at all sure I’m staying
onside with the CRA. Do you have any suggestions? – Adam K., Kingston, Ontario

A
– There’s nothing quite like the thrill of managing your own investments.
That is, until things go south and you wonder whatever possessed you to buy
that two-times daily bull crude oil ETF! Then there’s all that paperwork to
contend with (what the heck is a “T3 – Statement of Trust Income
Allocations and Designations”?) When should you sell to take a tax loss?
And can you apply it against gains? Those brokerage fees that get into
triple digits can really give you that sinking feeling at year-end (are
they deductible or not?). Take heart. You’re not doing anything wrong. But
you may have fallen into the trap that so many do-it-yourself investors do.
You’ve let your investments start controlling you instead of the other way
around.

All that buying and selling and selecting securities is exciting. And, of
course, the asset mix of your portfolio is even more important. But
do-it-yourselfers typically tend to overlook one of the biggest factors in
wealth creation: tax efficiency.

Research has shown that creating tax efficiency in your portfolio accounts
on average for about 28% of overall long-term investment returns.
Surprisingly, the factors with the next largest influence on your portfolio
returns are the time you spend on management, which accounts for 26% of
portfolio returns. Managing your emotions (all that fear and greed) adds up
to about 20% ranking.

Getting the asset mix right accounts for about 17% of what goes into total
returns. And security selection – something that investors spend the most
time on – has only a 2% importance ranking in determining long-term
portfolio outcomes.

These data tell us why so many do-it-yourself investors get into trouble:
They place too much importance on the aspects of portfolio management that
contribute the least to long-term portfolio growth.

It’s easy to get carried away with online trading in self-directed
investment accounts, but you may be generating hefty brokerage commissions
and accumulating a hefty tax bill along the way. It all takes a sizeable
chunk out of your investment returns and puts it in someone else’s pocket.
There’s probably no other activity in the world where individuals will so
eagerly perform a robbery on themselves.

The key is to step back from the trading screen for long enough to take a
look at your whole portfolio. Consider these three crucial factors:

* Tax efficiency: Are you minimizing the tax hit with
every investment and every transaction? Do you maximize the use of Tax-Free
Savings Accounts (TFSAs) and Registered Retirement Savings Plans?

* Cost: Do you have an eye to reducing overall trading,
transaction, and management costs? For example, do you allocate at least
some portion of your portfolio to low-cost exchange-traded funds? In the
case of mutual funds, look at corporate class shares, which are structured
for tax-efficient distributions.

* Risk: Are you diversifying your portfolio with enough
non-correlated asset classes to your risk-tolerance level? Are you using
hedging or income-generating strategies with options?

These are not particularly easy questions for a do-it-yourself investor to
answer. But if you’re having trouble sorting out how your various
investment activities are affecting your overall returns, you might
consider getting some help from an independent financial planner.

A good financial planner will look at your entire investment structure as a
single portfolio, including both registered accounts (RRSPs, TFSAs, IPPs,
and RESPs) as well as non-registered accounts like your self-directed
online brokerage. As a
Certified Financial Planner and investment manager
for my own clients, I look at how all these assets work together in terms
of tax efficiency and appropriate allocation. For many new clients who
thought they were doing just fine as DIY investors, the results can be
eye-opening. Many who thought they were being prudent and sensible were
shocked to discover they were in fact playing Vegas odds – not great!

As counterintuitive as it seems, then, for many DIY investors, an objective
review by an independent fee-only advisor (not one affiliated with a bank,
brokerage, or other financial institution) could go a long way to helping
get investments back on the right – tax efficient – track.

The foregoing is for general information purposes only and is the opinion
of the writer. Securities mentioned are illustrative only and carry risk of
loss. No guarantee of investment performance is made or implied. It is not
intended to provide specific personalized advice including, without
limitation, investment, financial, legal, accounting or tax advice. Please
contact the author to discuss your particular circumstances.